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Intermediate Accounting_IFRS_Ch09
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7/16/2019 Intermediate Accounting_IFRS_Ch09
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C H A P T E R 9
INVENTORIES:
ADDITIONAL VALUATION ISSUES
Intermediate AccountingIFRS Edition
Kieso, Weygandt, and Warfield
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1. Describe and apply the lower-of-cost-or-net realizable value rule.
2. Explain when companies value inventories at net realizable value.
3. Explain when companies use the relative sales value method to
value inventories.
4. Discuss accounting issues related to purchase commitments.
5. Determine ending inventory by applying the gross profit method.
6. Determine ending inventory by applying the retail inventorymethod.
7. Explain how to report and analyze inventory.
Learning Objectives
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Special
valuationsituations
Relative salesvalue
Purchasecommitments
Lower-of-Cost-
or-Net
Realizable
Value (LCNRV)
Valuation
Bases
Gross Profit
Method
Retail
Inventory
Method
Presentation
and Analysis
Net realizable
valueIllustration of LCNRV
Application of LCNRV
Recording net
realizablevalue
Use of anallowance
Recovery of inventory loss
Evaluation of rule
Gross profit
percentageEvaluation of method
Concepts
Conventionalmethod
Special items
Evaluation of method
Presentation
Analysis
Inventories: Additional Valuation Issues
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A company abandons the historical cost principle
when the future utility (revenue-producing ability)
of the asset drops below its original cost.
Lower-of-Cost-or-Net Realizable Value
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
LCNRV
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Net Realizable Value
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Estimated selling price in the normal course of
business less estimated costs to complete and
estimated costs to make a sale.
Illustration 9-1
Lower-of-Cost-or-Net Realizable Value
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Net Realizable Value
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Illustration 9-2
LCNRV Disclosures
Lower-of-Cost-or-Net Realizable Value
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Illustration of LCNRV: Regner Foods computes itsinventory at LCNRV.
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Illustration 9-3
Lower-of-Cost-or-Net Realizable Value
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Illustration 9-4
Methods of Applying LCNRV
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
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Methods of Applying LCNRV
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
► In most situations, companies price inventory on an
item-by-item basis.
► Tax rules in some countries require that companies usean individual-item basis.
► Individual-item approach gives the lowest valuation for
statement of financial position purposes.
► Method should be applied consistently from one period
to another.
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Cost of goods sold (before adj. to NRV) $ 108,000
Ending inventory (cost) 82,000
Ending inventory (at NRV) 70,000
Inventory 12,000
Loss due to decline to NRV 12,000
Inventory 12,000
Cost of goods sold 12,000
LossMethod
COGSMethod
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Recording Net Realizable Value Instead of Cost
Lower-of-Cost-or-Net Realizable Value
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COGS Loss
Method Method
Current assets:
Inventory 70,000$ 70,000$Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000
Statement of Financial Position Presentation
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
Partial Statement
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COGS Loss
Method MethodSales 200,000$ 200,000$
Cost of goods sold 108,000 120,000
Gross profit 92,000 80,000
Operating expenses:
Selling 45,000 45,000 General and administrative 20,000 20,000
Total operating expenses 65,000 65,000
Other income and expense:
Loss due to NRV on inventory 12,000 -
Interest income 5,000 5,000
Total other (7,000) 5,000
Income from operations 20,000 20,000
Income tax expense 6,000 6,000
Net income 14,000$ 14,000$
Income Statement Presentation
LO 1
Lower-of-Cost-or-Net Realizable Value
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Use of an Allowance
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an
allowance account.
Allowance to reduce
inventory to NRV 12,000
Loss due to decline to NRV 12,000LossMethod
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COGS Loss
Method Method
Current assets:
Inventory 70,000$ 82,000$Allowance to reduce inventory (12,000)
Inventory at NRV 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000
Statement of Financial Position Presentation
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
Partial Statement
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Recovery of Inventory Loss
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
► Amount of write-down is reversed.
►Reversal limited to amount of original write-down.
Continuing the Ricardo example, assume the net realizable
value increases to $74,000 (an increase of $4,000). Ricardo
makes the following entry, using the loss method.
Recovery of inventory loss 4,000
Allowance to reduce inventory to NRV 4,000
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Recovery of Inventory Loss
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
Lower-of-Cost-or-Net Realizable Value
Allowance account is adjusted in subsequent periods,
such that inventory is reported at the LCNRV.
Illustration 9-8
Inventory should not be reported at a value above original cost.
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Decreases in the value of the asset and the charge to expense are
recognized in the period in which the loss in utility occurs—not in the
period of sale. Increases in the value of the asset (in excess of original cost)
recognized only at the point of sale.
Inconsistency because a company may value inventory at cost in one
year and at net realizable value in the next year.
LCNRV values inventory conservatively. Net income for the year in
which a company takes the loss is definitely lower. Net income of the
subsequent period may be higher than normal if the expected
reductions in sales price do not materialize.
Some Deficiencies:
Lower-of-Cost-or-Net Realizable Value
Evaluation of LCM Rule
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
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P9-1: Remmers Company manufactures desks. Most of the
company’s desks are standard models and are sold on the basis of
catalog prices. At December 31, 2010, the following finished desks
appear in the company’s inventory.
Instructions: At what amount should the desks appear in the
company’s December 31, 2010, inventory, assuming that the company
has adopted a lower-of-FIFO-cost-or-net realizable value approach for
valuation of inventories on an individual-item basis?
Finished Desks A B C DFIFO cost inventory at 12/31/10 470$ 450$ 830$ 960$
Est. cost to complete and sell 50 110 260 200
Catalog selling price 500 540 900 1,200
Lower-of-Cost-or-Net Realizable Value
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
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P9-1: Remmers Company manufactures desks. Most of the
company’s desks are standard models and are sold on the basis of
catalog prices. At December 31, 2010, the following finished desks
appear in the company’s inventory.
Finished Desks A B C DFIFO cost inventory at 12/31/10 470$ 450$ 830$ 960$
Est. cost to complete and sell 50 110 260 200
Catalog selling price 500 540 900 1,200
Net realizable value 450 430 640 1,000
Lower-of-cost-or-NRV 450 430 640 960
Lower-of-Cost-or-Net Realizable Value
LO 1 Describ e and apply the lower-of-cos t-or-net real izable value rule.
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Special Valuation Situations
Departure from LCNRV rule may be justified in situations when
► cost is difficult to determine,
► items are readily marketable at quoted market prices, and
► units of product are interchangeable.
Two common situations in which NRV is the general rule:
► Agricultural assets
► Commodities held by broker-traders.
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Agricultural Inventory
Biological asset (classified as a non-current asset) is a
living animal or plant, such as sheep, cows, fruit trees, or
cotton plants.
► Biological assets are measured on initial recognition
and at the end of each reporting period at fair value
less costs to sell (NRV).
► Companies record gain or loss due to changes in NRV
of biological assets in income when it arises.
NRV
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Agricultural Inventory
Agricultural produce is the harvested product of a
biological asset, such as wool from a sheep, milk from a
dairy cow, picked fruit from a fruit tree, or cotton from acotton plant.
► Agricultural produce are measured at fair value less
costs to sell (NRV) at the point of harvest.
► Once harvested, the NRV becomes cost.
NRV
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Illustration: Bancroft Dairy produces milk for sale to local cheese-makers. Bancroft began operations on January 1, 2011, by
purchasing 420 milking cows for €460,000. Bancroft provides the
following information related to the milking cows.
Illustration 9-9
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Bancroft makes the following entry to record the change in carrying
value of the milking cows.
Unrealized Holding Gain or Loss—Income 33,800
Biological Asset—Milking Cows 33,800
Illustration 9-9
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Unrealized Holding Gain or Loss—Income 33,800
Biological Asset—Milking Cows 33,800
Reported in statement of financial position reports theBiological Asset—Milking Cows as a non-current asset at fair
value less costs to sell (net realizable value).
Reported as “Other income and expense” on the income
statement.
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Valuation Bases
LO 2
Illustration: Bancroft makes the following summary entry to record
the milk harvested for the month of January.
Unrealized Holding Gain or Loss—Income 36,000
Milk Inventory 36,000
Assuming the milk harvested in January was sold to a local cheese-
maker for €38,500, Bancroft records the sale as follows.
Cost of Goods Sold 36,000
Cash 38,500Sales 38,500
Milk Inventory 36,000
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Valuation Bases
LO 2 Explain when companies value inv entories at net real izable value.
Commodity Broker-Traders
Generally measure their inventories at fair value less costs to
sell (NRV), with changes in NRV recognized in income in the
period of the change.
► Buy or sell commodities (such as harvested corn, wheat,
precious metals, heating oil).
► Primary purpose is to sell the commodities in the near term and generate a profit from fluctuations in price.
NRV
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(1) a controlled market with a quoted price applicable to all
quantities, and
(2) no significant costs of disposal (rare metals and
agricultural products)
or (3) too difficult to obtain cost figures (meatpacking).
Permitted by GAAP under the following conditions:
Valuation Bases
Valuation Using Relative Sales Value
LO 3 Expla in when comp anies use the relat ive sales value method to value inventor ies.
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Used when buying varying units in a single lump-sum purchase.
Valuation Bases
Valuation Using Relative Sales Value
E9-9: Larsen Realty Corporation purchased a tract of unimproved land for
$55,000. This land was improved and subdivided into building lots at an
additional cost of $30,000. These building lots were all of the same size
but owing to differences in location were offered for sale at different prices
as follows. Operating expenses allocated to this project total $18,200.
Instructions: Calculate the
net income realized on this
operation to date.
No. of Price Lots Unsold
Group Lots per Lot at Year-End
1 9 3,000$ 5
2 15 4,000 7
3 19 2,000 2
LO 3 Expla in when comp anies use the relat ive sales value method to value inventor ies.
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Valuation Bases
E9-9 (Relative Sales Value Method):
No. of Price Selling Relative Total Cost Cost
Group Lots per Lot Price Sales Price Cost Allocated Per Lot
1 9 3,000$ 27,000$ $27,000/125,000 85,000$ 18,360$ 2,040$
2 15 4,000 60,000 60,000/125,000 85,000 40,800 2,720 3 19 2,000 38,000 38,000/125,000 85,000 25,840 1,360
125,000$ 85,000$
Lots Price Total Cost Total Cost Calculation of Net Income
Group Sold per Lot Sales Per Lot of Goods Sales 78,000$
1 4 3,000$ 12,000$ 2,040$ 8,160$ Cost of good sold 53,040
2 8 4,000 32,000 2,720 21,760 Gross profit 24,960
3 17 2,000 34,000 1,360 23,120 Expenses 18,200
78,000$ 53,040$ Net income 6,760$
x = x =
=x
LO 3 Expla in when comp anies use the relat ive sales value method to value inventor ies.
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► Generally seller retains title to the merchandise.
► Buyer recognizes no asset or liability.
► If material, the buyer should disclose contract details in
footnote.
► If the contract price is greater than the market price, and
the buyer expects that losses will occur when the
purchase is effected, the buyer should recognize a liability
and a corresponding loss in the period during which such
declines in market prices take place.
Valuation Bases
LO 4 Discuss account ing issu es related to purchase commitm ents.
Purchase Commitments—A Special Problem
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Valuation Bases
LO 4 Discuss account ing issu es related to purchase commitm ents.
Illustration: St. Regis Paper Co. signed timber-cutting contractsto be executed in 2013 at a price of $10,000,000. Assume further
that the market price of the timber cutting rights on December
31, 2012, dropped to $7,000,000. St. Regis would make the
following entry on December 31, 2012.
Unrealized Holding Gain or Loss—Income 3,000,000
Purchase Commitment Liability 3,000,000
Other income and expense in the Income statement.
Current liabilities on the statement of financial position.
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Valuation Bases
LO 4 Discuss account ing issu es related to purchase commitm ents.
Illustration: When St. Regis cuts the timber at a cost of $10million, it would make the following entry.
Purchases (Inventory) 7,000,000
Purchase Commitment Liability 3,000,000
Cash 10,000,000
Assume the government permitted St. Regis to reduce its contract
price and therefore its commitment by $1,000,000.
Purchase Commitment Liability 1,000,000
Unrealized Holding Gain or Loss—Income 1,000,000
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Relies on Three Assumptions:
Gross Profit Method of Estimating Inventory
LO 5 Determine ending inventory by apply ing the gross prof i t method.
Substitute Measure to Approximate Inventory
(1) Beginning inventory plus purchases equal total goods to
be accounted for.
(2) Goods not sold must be on hand.
(3) The sales, reduced to cost, deducted from the sum of the
opening inventory plus purchases, equal endinginventory.
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Gross Profit Method
LO 5 Determine ending inventory by apply ing the gross prof i t method.
Illustration: Cetus Corp. has a beginning inventory of €60,000and purchases of €200,000, both at cost. Sales at selling price
amount to €280,000. The gross profit on selling price is 30
percent. Cetus applies the gross margin method as follows.
Illustration 9-13
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Gross Profit Method
LO 5 Determine ending inventory by apply ing the gross prof i t method.
Computation of Gross Profit PercentageIllustration 9-16
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E9-14: Astaire Company uses the gross profit method to estimateinventory for monthly reporting purposes. Presented below is
information for the month of May.
Instructions:
(a) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of sales.
(b) Compute the estimated inventory at May 31, assuming that the
gross profit is 25% of cost.
Inventory, May 1 € 160,000
Purchases (gross) 640,000 Freight-in 30,000
Sales 1,000,000
Sales returns 70,000
Purchase discounts 12,000
Gross Profit Method
LO 5
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E9-14 (Solution):
Inventory, May 1 (at cost) € 160,000
Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at sell ing price) € 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less gross profit (25% of €930,000) 232,500
Sales (at cost) 697,500
Approximate inventory, May 31 (at cost) € 120,500
(a) Compute the estimated inventory assuming gross profit is 25% of sales.
Gross Profit Method
LO 5 Determine ending inventory by apply ing the gross prof i t method.
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(b) Compute the estimated inventory assuming gross profit is 25% of cost.
E9-14 (Solution):
Inventory, May 1 (at cost) € 160,000
Purchases (gross) (at cost) 640,000
Purchase discounts (12,000)
Freight-in 30,000
Goods available (at cost) 818,000
Sales (at sell ing price) € 1,000,000
Sales returns (at selling price) (70,000)
Net sales (at selling price) 930,000
Less gross profit (20% of €930,000) 186,000
Sales (at cost) 744,000
Approximate inventory, May 31 (at cost) € 74,000
Gross Profit Method
LO 5 Determine ending inventory by apply ing the gross prof i t method.
25%
100% + 25%= 20% of sales
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Disadvantages:
Gross Profit Method
LO 5 Determine ending inventory by apply ing the gross prof i t method.
Evaluation
(1) Provides an estimate of ending inventory.
(2) Uses past percentages in calculation.
(3) A blanket gross profit rate may not be representative.
(4) Normally unacceptable for financial reporting purposes.
IFRS requires a physical inventory as additional
verification.
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Retail Inventory Method
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
A method used by retailers, to value inventory without aphysical count, by converting retail prices to cost.
(1) Total cost and retail value of goods purchased.
(2) Total cost and retail value of the goods available for sale.
(3) Sales for the period.
Requires retailers to keep:
Conventional Method or Cost Method
(based on LCNRV)
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P9-9: Fuque Inc. uses the retail inventory method to estimate
ending inventory for its monthly financial statements. The
following data pertain to a single department for the month of
October 2011.
Retail Inventory Method
COST RETAILBeg. inventory, Oct. 1 52,000$ 78,000$
Purchases 272,000 423,000
Freight in 16,600
Purchase returns 5,600 8,000
Additional markups 9,000
Markup cancellations 2,000 Markdowns (net) 3,600
Normal spoilage 10,000
Sales 390,000
Instructions:
Prepare a schedule
computing estimate
retail inventory using
the following
methods:(1) Conventional
(2) Cost
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
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Retail Inventory Method
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
P9-9 Solution - CONVENTIONAL Method:
Cost toCOST RETAIL Retail %
Beg. inventory 52,000$ 78,000$
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markups, net 7,000
Current year additions 283,000 422,000
Goods available for sale 335,000 500,000 67.00%
Markdowns, net (3,600)
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail 96,400$
Ending inventory at Cost:
96,400$ x 67.00% = 64,588$
= /
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Retail Inventory Method
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
P9-9 Solution - Cost Method Cost to
COST RETAIL Retail %
Beg. inventory 52,000$ 78,000$
Purchases 272,000 423,000
Freight in 16,600
Purchase returns (5,600) (8,000)
Markdowns, net (3,600) Markups, net 7,000
Current year additions 283,000 418,400
Goods available for sale 335,000 496,400 67.49%
Normal spoilage (10,000)
Sales (390,000)
Ending inventory at retail 96,400$
Ending inventory at Cost:
96,400$ x 67.49% = 65,056$
= /
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Special Items
Retail Inventory Method
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
Freight costs
Purchase returns
Purchase discounts and allowances
Transfers-in
Normal spoilage
Abnormal shortages
Employee discounts
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SpecialItems
Retail Inventory Method
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
Illustration 9-22
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Widely used for the following reasons:
Evaluation
(1) To permit the computation of net income without a
physical count of inventory.(2) Control measure in determining inventory shortages.
(3) Regulating quantities of merchandise on hand.
(4) Insurance information.
Retail Inventory Method
LO 6 Determine ending in ventory by apply ing the retai l inventory method.
Some companies refine the retail method by computing inventory separately by
departments or class of merchandise with similar gross profits.
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Accounting standards require disclosure of:
Presentation and Analysis
LO 7 Expla in how to report and analyze inventory.
Presentation of Inventories
(1) Accounting policies adopted in measuring inventories,
including the cost formula used (weighted-average, FIFO).(2) Total carrying amount of inventories and the carrying amount
in classifications (merchandise, production supplies, raw
materials, work in progress, and finished goods).
(3) Carrying amount of inventories carried at fair value less coststo sell.
(4) Amount of inventories recognized as an expense during the
period.
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Accounting standards require disclosure of:
Presentation and Analysis
LO 7 Expla in how to report and analyze inventory.
Presentation of Inventories
(5) Amount of any write-down of inventories recognized as an
expense in the period and the amount of any reversal of write-downs recognized as a reduction of expense in the
period.
(6) Circumstances or events that led to the reversal of a write-
down of inventories.
(7) Carrying amount of inventories pledged as security for
liabilities, if any.
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Presentation and Analysis
LO 7 Expla in how to report and analyze inventory.
Common ratios used in the management and evaluation of
inventory levels are inventory turnover and average days
to sell the inventory.
Analysis of Inventories
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Measures the number of times on average a company
sells the inventory during the period.
Presentation and Analysis
LO 7 Expla in how to report and analyze inventory.
Inventory Turnover Ratio
Illustration 9-25
Illustration: In its 2009 annual report Tate & Lyle plc (GBR)
reported a beginning inventory of £562 million, an ending inventory
of £538 million, and cost of goods sold of £2,019 million for the
year.
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Measure represents the average number of days’ sales
for which a company has inventory on hand.
Presentation and Analysis
LO 7 Expla in how to report and analyze inventory.
Average Days to Sell Inventory
365 days / 3.67 times = every 99.5 days
Average Days to Sell
Illustration 9-25
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The requirements for accounting for and reporting inventories are more
principles-based under IFRS. That is, U.S. GAAP provides moredetailed guidelines in inventory accounting.
Who owns the goods—goods in transit, consigned goods, special sales
agreements—as well as the costs to include in inventory are essentially
accounted for the same under IFRS and U.S. GAAP.
U.S. GAAP permits the use of LIFO for inventory valuation. IFRS
prohibits its use. FIFO and average cost are the only two acceptable
cost flow assumptions permitted under IFRS. Both sets of standards
permit specific identification where appropriate.
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In the lower-of-cost-or-market test for inventory valuation, IFRS defines
market as net realizable value. U.S. GAAP, on the other hand, definesmarket as replacement cost subject to the constraints of net realizable
value (the ceiling) and net realizable value less a normal markup (the
floor). IFRS does not use a ceiling or a floor to determine market.
Under U.S. GAAP, if inventory is written down under the LCM valuation,
the new basis is now considered its cost. As a result, the inventory may
not be written back up to its original cost in a subsequent period. Under
IFRS, the write-down may be reversed in a subsequent period up to the
amount of the previous write-down. Both the write-down and any
subsequent reversal should be reported on the income statement.
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Unlike property, plant, and equipment, IFRS does not permit the option
of valuing inventories at fair value. As indicated above, IFRS requiresinventory to be written down, but inventory cannot be written up above
its original cost.
As indicated, IFRS requires both biological assets and agricultural
produce at the point of harvest to be reported to net realizable value.
U.S. GAAP does not require companies to account for all biological
assets in the same way. Furthermore, these assets generally are not
reported at net realizable value. Disclosure requirements also differ
between the two sets of standards.
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